Platforum: Does fractional share trading add up for platforms?

To round off our series looking at platform technology, we turn our attention to fractional share trading. Despite the technology having been developed to enable it, no adviser platform currently offers this kind of service. This is set to change, however, with the launch of Winterflood Business Service’s bolt-on solution on Novia’s platform, which is due soon, with at least one other hot on its heels.

“So what?” you may ask. Well, in this case, the “so what?” is ETFs.

In our recent report, UK Fund Distribution: Passives, ETFs and Smart Beta, we talk about the rise of passive investing. Investment Association data shows 40 per cent of net retail sales go to tracker funds, with a clear up-tick in assets under management since the RDR. But our research also shows that this growth in sales has not trickled down to ETFs.

Our recent survey of financial advisers found that, while 62 per cent had recommended a tracker fund, only 19 per cent had recommended an ETF. Of the advisers that had recommended ETFs, all but two had bought them on platform. Assets in ETFs on adviser platforms stands at 1.3 per cent of the total platform assets under administration, far lower than the percentage of assets in tracker funds.

The pressure to reduce the client’s total cost of investing means advisers and discretionary fund managers are increasingly using tracker funds and ETFs in model portfolios. Some notable DFMs are increasing their use of passives: for example, JM Finn uses a core/satellite approach, blending passive and active strategies, and Seven Investment Management exclusively uses passives in model portfolios. Some are starting to blend tracker funds and ETFs in models but, unlike their robo cousins, it is still rare for them to offer all-ETF model portfolios.

In certain circumstances, there are clear advantages of using ETFs. For example, there is a greater range and choice available than there is with tracker funds. So ETFs can help portfolio diversification in sectors tracker funds cannot, while keeping the underlying fund charges of portfolios down. That said, there are three barriers to using ETFs on platform that simply do not exist for tracker funds. These are:

Higher transaction costs on adviser platforms

Inability to trade intra-day

Lack of fractional share trading

While mutual fund units are commonly split into fractions and can be bought and sold in this way, ETFs must be traded as complete shares. This creates problems for model portfolio re-balancing on platforms and is undoubtedly blocking wider adoption of ETFs. It also creates problems around accepting regular contributions into ETF model portfolios.

One DFM we spoke to illustrated the point as such: “We have the capability to invest in ETFs but for a £100 minimum investment. If an ETF is £93, fractional trading would have to come in as the ETF would have to be split up across a multi-asset portfolio.”

ETF providers are lobbying adviser platforms to enable fractional share trading, particularly because of its importance to DFMs when model portfolios are re-balanced. But there are structural challenges to fractional share trading that must be tackled. For example, the re-registration of fractional shares to a platform that does not cater for them needs to be ironed out. That said, there is confidence these difficulties can be overcome.

In the robo world, Nutmeg has developed a solution for fractional share trading and ownership. However, its solution is for its own benefit, whereas Winterflood’s is industrywide.

Winterflood’s solution is a bolt-on to the core adviser platform technology. Platforms will have to evaluate whether to bear the cost of implementing it. If FNZ, GBST, Bravura or IFDS Bluedoor builds fractional share trading into their core systems then another barrier to using ETFs on-platform will be broken down.

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